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96 Deleveraging, What Deleveraging Afternoon general discussion Part of the discussion concerned sequencing. Alexander Swoboda described a caricature of the usual sequencing discussion as prevention, mitigation and resolution. The experience is that we have not prevented the crisis very well, that we mitigated it somewhat and that we have not resolved the problem yet. Claudio Borio has observed that it is never a good time to solve problems or to reform. When you are on the upswing of the credit or leveraging cycle, you don’t want to take the ‘punch bowl’’ away because you might be accused of having aborted the recovery. And when you are in the down phase of the business cycle, it is really not the time for austerity, to put an additional burden on the banks, and so on. Then we find ourselves in a situation where we are damned if we do and damned if we don’t. Interest rates have been low and that was necessary for one goal, but we don’t dare raise them to prevent the next bubble or crisis and perhaps the next crisis will come. A useful reminder is provided in the summary of the paper ‘’ Resolving Debt Overhang: Political Constraints in the Aftermath of Financial Crises” by Mian et al. (2014), which ends: ‘This paper advances the idea that countries become more politically polarised and fractionalised following financial crises reducing the likelihood of major financial reforms precisely when they might have especially large benefits.” Laurence Boone argued that the Eurozone cannot have the same sequencing as the US because it is not a federation. Indeed, in 2010-11 the markets and policymakers were talking about a Eurozone breakup. The UK regulator was asking banks every month about their contingency plans if a breakup were to happen. The Eurozone could have had the same sequencing as the US if it had decided to move to a fiscal union and the debt of the region was serviced by the entire Eurozone GDP. Instead, the debt of Italy is being serviced by the GDP of Italy, and so on. However, once the Eurozone decided to stick with the ‘limited liability partnership’ that we have today, the sequencing of policies could not proceed in a similar manner to that of the US. According to José Luis Malo de Molina, there is nothing to object to regarding the sequencing proposed in the report, but in practice very important problems arise. The first problem is how to implement a strategy of fiscal consolidation and austerity until the end of the process. Policymakers need from the beginning to have a credible strategy of medium-term fiscal consolidation. We have seen what has happened in Greece, Portugal, Spain and Ireland, where problems of credibility were at the core of the problem from the beginning. Second, in order to sort out the banking system, policymakers need a lot of public money. To do it in a credible way, government balance sheets need to be healthy. If not, it is very hard to implement the sequencing suggested by the report, as it means leaving austerity until the end of the process. Finally, when comparing the size and the timing of the ECB and Fed interventions, the most important factor is the channel. The channels used by the Fed and ECB are different because the markets in the US are different from those in Europe. The kinds of assets that can be purchased by the ECB are different from the ones that can be purchased by the Fed. The guidance channel, an attempt to affect the final prices, is also different. Laurence Boone reinforced this analysis, asking how the ECB can buy assets
Discussions 97 when there is no commitment from 18 different national treasuries guaranteeing the risk. In the US and the UK, the treasury guarantees the central bank’s risks. No treasury has promised such a guarantee in the Eurozone and the only offer was the guarantee of the balance sheet of the EIB, which is relatively small. This is more a political issue than an institutional one. Edmond Alphandéry picked up on the issue of the monetary policy stance before and after the crisis. He asserted that it is difficult to describe what happened in the US, the EU and in emerging markets without trying to explain the links that exist between the evolution in leveraging and quantitative easing in the US, Japan and the UK and the monetary policy of the ECB. A good guess involves the evolution of capital flows and carry trade. The international monetary system creates a lot of linkages, which has resulted in disequilibria between the regions of the world. The monetary policy of very low interest rates in the US in the 2000s created excessive demand, not just in the US but worldwide. After the crisis, Europe and the rest of the world were forced to react in the same way. For Richard Portes, while the eventual exit from the current very low interest rate policy is warranted, the same is not necessary true about shrinking central bank balance sheets. The choice is presented as being between a balance sheet reduction and an increase in the price. This is not obvious; at least there is a theoretical disagreement about this. Another issue concerns indebtedness. According to Reinhart et al. (2012), historically the debt-to-GDP ratio has been reduced by an increase in the growth rate. However, there is a lot of disagreement about this result; detailed studies say the opposite for the post-World War II period. In addition, the story of secular stagnation implies that interest rates are going to stay low for a long period of time and the problem of debt is so big anymore. Jacques Delpla noted that the story up to now has been about the supply of debt. When we talk about too much leverage, we mean that there is too much debt but also too little equity. At least in Europe, regulation is such that everybody wants to buy debt. For example, banks must hold government debt for their reserves, insurance companies must have extremely secure debt, with MiFID regulation a retail investor must invest in safe assets, and Asian central banks buy safe government bonds. Taxation too treats debt more favourably than equity. Shouldn’t we be also talking about that Many conference participants challenged the view that China is in a highly dangerous situation. Carlo Monticelli recalled that China has $4 trillion in foreign reserves. This is an important buffer to cope with both financial shocks and ageing, and a good reason to be less pessimistic about China. Yet another reason to be less pessimistic is the army of peasants that can be turned into factory workers or capital-intensive farmers, with huge potential increases in productivity and effective demand. They are a source of strength for China. This fact can allow the authors to tone down their pessimism on China. The difficulties of the transformation of peasants into workers, and the number of changes of institutions that need to take place in China every year, are mind boggling, but they are mainly politics. Amlan Roy disagreed with Carlo Monticelli. He recalled the hukou system that goes back 56 years. The risk now is a shortage of labour after 2021. In fact, China is already exporting inflation to the rest of the world
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Geneva Reports on the World Economy
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International Center for Monetary a
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International Center for Monetary a
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Acknowledgements We thank Susan Lun
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List of Conference Participants Edm
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List of Conference Participants xi
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List of Conference Participants xii
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Foreword Since 1999 the Geneva Repo
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